The Demise of International Harvester

In 1971, International Harvester Company brought in Keith Mazurek a former
Chrysler Corporation executive from Canada, to bring along that super-sell
Detroit-type thinking. However some would not believe that he could persuade
management to double the advertising budget, to $3.5 million, in a recession
year. However when he said he wanted to blow more than a third of the total
budget to introduce a single new product -- well think of what they thought of
that!

IH took every possible commercial minute on three successive nights in
NBC’s Johnny Carson Tonight Show, CBS’s Merv Griffin Show, and ABC’s Dick
Carett Show. The total cost of each program -- a different show each night was
$450,000, and the money used to introduce this week’s new Scout II, along with
International’s light -- truck line. Also in addition to the television spots
in prime time and in Sunday sport shows, along with the Sunday newspaper
supplement ads in 380 markets, total an introductory budget of $1.2 million for
the Scout. The Scout II is a Four-wheel-drive sport utility vehicle for hunters,
campers, skiers, and other recreational users to just get out of town for the
weekend.

New tack.

The big push highlighted an all-out campaign to make IH a strong competitive
force in the marketing of light trucks as it has long been in heavy trucks.
Since it started in 1907 with an “auto wagon” for its farm implement
customers, IH has offered a great deal of variety of work vehicles. Truck sales
accounted for $1.336-billion, or half of the company’s total volume. For a
long time now IH has traditionally concentrated on heavy duty vehicles (gross
weight of 26,000 pounds or more), and held a hand full of shares for that market
since World War II. In 1964, the best year had come. It owned 31% of the heavy
duty market, in the early 70s IH hovered around 25%. In a different weight
class, penetration in the medium-weight market (14,00 pounds to 26,000 pounds)
has varied from 17% to 21%. The absolute best IH could achieve in light truck
share-of-market was 9.5% and in 1969 it was down to 4.1%.

William E. Callahan, Executive vice-president of IH, saw that something
needed altered to make full capability of International’s huge light-truck
production facilities. Callahan recruited Mazurek, who had started 20 years
earlier as a graduate student at the Chrysler Institute of Engineering and
Subsequently held numerous engineering posts. Mazurek had been “a
plant-oriented guy who thought in terms of production.” Now he became a
marketing person.

Modern design.

Mazurek changed the IH division’s name from “Motor Truck,” that smacked
of the 1930s, to simply “Truck.” He also changed the color design in the
plants from a uniform “kind of greasy Sherwood Forest green” to bright blue.
Then he reorganized the company’s dealer organization, dropping some 650 who
handled the Scout Travelall (a truck-like station wagon), and pickups-who had a
low volume and limited service capability. He added a total of 150 new dealers
and ended up with a total of 2,840 dealers, 840 that sell the IH vehicle lines
along with various others that range from Rolls-Royce and Checker to
Chrysler-Plymouth and Oldsmobile. Then he cut prices from $100 to $150 and
modified warranties to make his trucks more competitive with Detroit’s.

“To sell light trucks,” Mazurek says, “we had to get onto automobile
row." Pickups mostly sold out on the farm but that was years ago. Another
step was to consolidate sales regions and establish a profit-center set-up.

Archie R. McCardell, 54, who was head chairman and chief executive of
International Harvester has had a busy year. From November 1979 until late April
1980, McCardell suffered a devastating strike that he mistakenly thought he
could win. In mid-October he took in a $150-million sale of Harvester
convertible preferred stock on excruciating terms: an 11.9% dividend cost (after
tax because preferred dividends are not deductible) and a structure permitting
conversion into common at about 70% of book value. What also happened in
October, he closed the books on a fiscal year in which Harvester lost
approximately $400 million and watched its net worth dropped by 20%. In August,
Harvester’s directors, leaning on a “spectacular performance” clause in
his compensation contract, bequest McCardell forgiveness of a $1.8-million loan
that he owed the company.

The $1.8-million loan was part of a wealthy package that lured McCardell in
1977 from Xerox, where he was president and Number 2 man. Not bad as a starter,
the package included a kind offer, though more or less standard, salary and
bonus arrangements (worth more than $800,000 in fiscal 1979).

Wrinkles in a record year

Lo and behold Harvester’s 1979 profits, despite a $45-million blow from
LIFO, were record high at the amount of $370 million and its ratio, at 9.55%,
exceeded parity. McCardell’s cost-cutting drive and good marketing supplied
the main heave ho. Some problems included U.K. tax credit, amounting for
Harvester to $49 million. The other one was anticipatory buying on the part of
Harvester’s dealers, who began to load up on inventory when they learned that
a serious strike could develop at the end of the fiscal year.

On these special occasions alone, the directors should have argued the point
more conscientiously should have taken a conservative approach toward a
forgiveness award in 1979. Moreover they did not get around to determining the
award until August 1980, and by that time the company was in so much trouble
that one would think the directors might have been heading for the escape pod.
The strike, called by the United Auto Workers, was over by then. Harvester had
largely failed in its goals and expectations of eliminating certain operating
practices that put it at a disadvantage to its competitors, and in the
strike’s nearly six months Harvester had lost a lot of money: $479 million.
Emerging in a recession, Harvester had no expectations of recuperation much in
the second half. As things developed, more things went wrong in the way of
money, the estimated $400 million the company lost for the full year more than
wiped out the $370 million made in 1979.

In addition, Harvester’s balance sheet, not strong when the strike began,
was a total wreck by August. The balance sheet showed substantially more debt
than equity and an acute shortage of working capital. The company had an intense
need by then to sell equity, but was burdened with a stock price back down near
$30 (which was its level also in mid-November).

Working with an agenda prepared by Harvester insiders. The committee took up
the question of what, if anything, McCardell should get in the way of a
forgiveness award for 1979. Was that brief, shining moment justification for
total forgiveness? OR did the warts on 1979’s performance and the tumble into
trouble in 1980 makes a case for only partial forgiveness or none at all?

The directors did not have to start from scratch on this decision. The
committee accepted the advice from the legal counsel to give him total
forgiveness. Adhering to a command of the contract that says literal forgiveness
would spread out over five years--that is, in one portion of $359,250
immediately and four such portions to come.

Joseph Lanterman, one of the directors presents that day, says he does not
remember facing the word “required.” He thought forgiveness would be proper:
“It was all justifiable by virtue of the contract.”

Rettaliata, chairman of the committee, says he thought McCardell was doing
“a fine job.” He also said, “We were just carrying out the contract.”
The media has asked him whether he had thought about the U.K. tax credit, the
prestike buying, and the contract’s admonition that the committee should
consider other matters beyond a “rigid formula.” Upon that, he said,
“Maybe we should have had you in the meeting.” It was not clear whether he
was being sarcastic or had just expanded his knowledge of the situation.

There may have been reluctance

Rettaliata says there was no argument about McCardell’s award at either the
committee meeting or on the following day, when the full board accepted the
committee’s decision. That action was unanimous, but Rettaliata speaks of it
in a way that suggests one or more of the directors gave their okay reluctantly.
One such person may have been Mary Garst, manager of the cattle division of
Garst Company in Iowa and a relatively new Harvester director. When FORTUNE
magazine had asked Mary Garst to give her personal opinion about forgiveness of
the loan, she said, “I really cannot--and the fact that I cannot should
suggest how I feel about it.”

Another director, Andrew F. Bremmer, a former Fed governor and now head of
his own Washington consulting firm, says firmly that he believes the board was
not “required” to forgive McCardell’s loan. He for one, wanted to do it.
“I believe the terms were met and I was enthusiastic about the
forgiveness." “Brimmer says he knew all about the escape clause."
“I didn’t choose to use it.”

Brooks McCormick and other directors felt some obligation to McCardell.
Rettaliata noted recently that Harvester’s poor profits will mean no bonus for
McCardell this year. He added: “You know, he gave up a lot when he left
Xerox.”

The last chance maybe

That would have been a poor reason for giving an incentive-based loan, but
Rettaliata and other directors may believe that McCardell has made real progress
and that the company has just bumped into bad luck that year. They could well
expect him to be ultimately innocent. They might be right, though the company
financially strained so it is hard to imagine a prompt recovery. The implication
of a slow recovery is clear: 1979 may have been the last year during the
contract term in which total forgiveness would only remotely justify their
actions. Maybe that’s why the directors tendered it now.

Investors, pondering this affair, might find some comfort in the knowledge
that this exotic contract has now gone. They should be apprehensive, however,
that there is at least one other such contract extant, and it too is at
Harvester. The contract belongs to Warren J. Hayford, who in 1979 left
Continental Group to become president under McCardell. Hayford got a loan worth
$973,000 to buy Harvester stock, and the contract says forgiveness, beginning in
fiscal 1980, that dismal year at Harvester, was to be linked to the speed at
which McCardell’s loan was forgiven. That link broke, since McCardell’s
forgiveness been based on fiscal 1979. So what is to happen now? Harvester said
last week that Hayford will get forgiveness merely by remaining at the company
until 1984.

International Harvester: When cost-cutting threatens the future

When International Harvester Company closed its books on fiscal 1979, ended
last October 31, Chairman Archie R. McCardell savored a momentary taste of the
fatter profits he covets for the $8.4 billion manufacturer of trucks, farm
implements, and construction equipment. Thanks to a surge in all three key
markets-and the success of a cost-cutting campaign that McCardell says has saved
$460 million in two years-the company’s earnings soared 98% last year to $370
million, producing an after-tax margin of 4.4%, a $15-year high.

The turnaround has dangerously suspended in to midair. McCardell has chosen
1980 as the year to engage the powerful United Auto Workers in the most risky
battle of Harvester’s cost reduction war. By demanding union work rule
concessions in a new contract rather than simply granting wage and benefit
increases already won by the UAW at competitor companies, Harvester triggered a
strike on November 1 by 35,000 workers, or 36% of its work force. The company
has estimated it will lose $225 million in the quarter ending January 31 an
amount equal to 10% of Harvester’s equity. Union officials perceive this
struggle as an outgrowth of McCardell’s obsessed in slashing costs.

Outspent by competitors. For the long term, the strike may throw a monkey
wrench into McCardell’s ambitious capital expansion program, under which
Harvester plans a capital outlay of $2.5 billion from 1980 through 1984,
compared with $1 billion in the previous five-year period.

Already, however, the strike has forced McCardell to reduce his company’s
capital spending plans for 1980 from $500 million to $400 million. Nevertheless,
he vows to continue fighting for concession from the UAW, which he contends are
as essential as capital improvements to put Harvester on an equal footing on
costs with its competitors and give it the financial muscle to carry out future
spending plans. Nightmarish scheduling. Among other things, Harvester wants the
UAW to give the company more flexibility in mandating overtime work. At Deere,
UAW members must work three Saturdays a month if asked, although they may refuse
on five occasions per year. At Harvester, prior labor contracts have always
entitled workers to turn down Saturday overtime whenever they please, making
weekend scheduling a nightmare. Because of such practices, McCardell says, “We
are losing between 1.5% and 2% in our margins through plant inefficiencies. If
we’re going to be competitive we have to get at that cost penalty, so we are
really serious about the strike.”

Unfortunately, so is the UAW, whose strike fund--kept intact when an auto
strike failed to materialize in 1979--now totals a comfortable $300 million.
Both sides are so entrenched, that no negotiations been scheduled for most of
December and January.

By taking his tough stand with labor, McCardell is raising questions in the
investment community and among competitors. They sympathize with Harvester’s
plight. “The company by far has got the worst union contract in the
business,” agrees one industry labor negotiator. There is concern about the
strike’s cost and its impact on McCardell’s schedule to catch up in plant
modernization and product development. Even with a quick end to the strike,
Harvester will barely break even in 1980 and may have to cut its dividend. It
looks as if the company will be at least a year behind where it hoped to be
[with its turnaround plan]. No better time. Although McCardell seems fully aware
of the costs of the strike, he maintains there will be no better time in the
near future to drive a hard bargain with the union. He also knows that because
Deere and Caterpillar endured shorter strikes of their own late last year, they
do not yet have the inventory to exploit fully the openings in their markets,
where growth is expected to slacken this year because of the Soviet grain
embargo and general economic conditions. As a former Ford Motors Co. Executive
before moving to Xerox, McCardell also knows the union he is up against.

Thus, apart from the stymied effort to improve labor efficiency, McCardell
sees himself as essentially moving ahead with the other aspects of his plan.
Potter had hired 300 scientists and engineers to staff 22 new corporate
technology teams, which will report to him on projects ranging from vehicular
electronics to development of exotic body and structural materials.

More technological stretch. In 1979, Harvester spent 2.6% of its sales on
R&D, well under the 3.8% of sales spent by Deere and about 3.5% by
Caterpillar. McCardell has picked this area as a specific target for reversal.
Harvester hopes to boost R&D spending sharply that year despite the strike,
and within five years McCardell sees Harvester as being among the most generous
spenders.

Such rhetoric is typical of most executives trained in the word processing
industry but is atypical of McCardell. At Xerox, McCardell was known as an
effective budgetary and organizer, but the company’s record of innovation
declined noticeably during his tenure as president and chief operating officer
from 1971 to 1977.

So far, however, Harvester has been more creative under McCardell than
before. Despite limited budgets, the five product groups--truck, farm,
construction, turbines, and components--recently have turned out some successful
new machines. The $3 billion farm group, which contributed more than half of
that one year’s corporate operating profit, gained market share with a new
rotary combine which boasts a gentler rubbing action to separate grain from the
chaff, and with a small, highly maneuverable four-wheel-drive tractor called the
“2 + 2.” Work on both products actually began before McCardell arrived at
Harvester, but the new chairman accelerated their development. He has also
initiated design work on a new generation of fuel-efficient tractors. In the
meantime, McCardell is moving forward with his cost-cutting plans. Since he
joined the company, he claims to have eliminated 11,000 jobs out of 15,000 he
wants to cut eventually. While he has had to add other positions in order to
handle Harvester’s 40% sales growth during the last three years, the net
result has been that total employment has risen only from 93,200 to 97,660.

Foreign growth. Once the impact of the UAW strike is absorbed, McCardell
hopes to return to his five-year plan to invest $500 million a year to bring in
more new and sophisticated production machinery as well as to broaden product
lines and marketing penetration in the U.S. McCardell want especially to expand
the company’s mix of Construction equipment, sales of which then totaled 1
billion. He is also attempting to grow internationally. Harvester bought its way
into the booming Brazilian agriculture industry by purchasing one-third of the
equity of a combine manufacturer there. McCardell says he also envisions a
bigger role in Europe for his truck group, whose 1979 world revenues were $4
billion. Harvester falls flat on its bargaining goals.

International Harvester Company is on the verge of settling a bitter
five-month strike by the United Auto Workers, but the $8.4 billion manufacturer
of trucks, farm implements, and construction equipment is emerging from
negotiations with deep financial wounds, lost market share, and no clear
contract victories. In resolving the stickiest issue, Harvester backed down from
its key demand, which was designed to enable it to force overtime work at its
manufacturing plants. Moreover, the company is gaining only partial relief on
its second pivotal proposal, aimed at restricting excessive transfers of
employees between different jobs.

Harvester is paying dearly for its tough bargaining stance. The company took
a $222 million loss in the quarter that ended January 31, and with most
second-quarter production already wiped out, total strike related losses could
exceed $350 million. Debt has ballooned 43% to about $1.9 billion, the
company’s commercial paper rating has been lowered one notch to Prime-2 by
Moody’s Investors Service, and Harvester’s stock has withered to less than
$27 per share from a 12 month high of $45.50. On the overtime issue, the company
apparently has given up trying to get the right to require at least 14 Saturdays
of work annually.

At auto plants, workers would welcome some overtime. In a sister industry,
extra hours became an emotional issue that fanned a long walkout.

While workers in other industries struggle to keep their jobs, 35,000
employee’s of International harvester have stayed on strike almost six months
to protect something even more dear to them--their leisure time. Their
determination appears to have had its effect. Management of the huge
farm-equipment company has softened its demand that employees be required to
work overtime, and a compromise that signals an end to the dispute sometime soon
appears to have been hammered out. Effects of the walkout are being felt sorely
by the company, the workers and businesses that rely on harvester trade. By the
end of February, the strike had set a record as the longest against a multiplant
company by the United Auto Workers, surpassing a 113 day walkout at General
Motors in 1946. With 17 of its 21 U.S. plants paralyzed, Harvester reported a ?
Wages, fringe benefit and other “bread and butter” demands by the UAW. The
company made it clear from the beginning that it would match the three-year, 33
percent wage and fringe benefit increase negotiated at other farm implement
firms last fall, but other details remained to be worked out. ? Job transfers.
The company demanded a limit to excessive transfers of employees from on job to
another. The issue was dropped from national talks and sent to plant level
negotiations. Management neutrality. The union wanted company managers to remain
neutral in union organizing drives at a handful of plants not represented by the
UAW.

Both sides say they are not far apart on remaining issues. National talks
have been stalled since early February and are not scheduled to resume until
local contracts, covering 34 bargaining units, are settled. Officials say those
agreements could fall into place soon. Both union and company sources say a
tentative agreement has been reached on a compromise--short of a mandatory
plan--that will help ensure adequate staffing of overtime shifts. With national
talks about to resume, some say an agreement should come quickly now that the
most emotional issue has been resolved.

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